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Cape Town - The rand remains below successive support levels suggesting a continuation in the rand’s depreciation, according to Overberg Asset Management in its weekly overview of the economic and political landscape in South Africa.
SA economic review
• In the past week the rand firmed again against the US dollar, euro and pound sterling from R/$14.61 to 14.40, from R/€16.51 to R16.19, and from R/£20.73 to R20.72 respectively. However, the gains were attributed to a broad-based rally in emerging market currencies evidenced by only a mild appreciation of the rand against its peer group. The rand appreciated versus the Indian rupee (+1.0%), Indonesian rupiah (+1.4%), Korean won (+0.8%), Malaysian ringgit (+1.2%), Thai baht (+1.0%) and Singapore dollar (+0.4%). Rand gains versus emerging market currencies were tempered by the market’s weak response to President Zuma’s letters of reprimand to ministers involved with the Nkandla scandal. The letters were instructed by the Public Protector but appeared to lack sincerity.
• Consumer price inflation (CPI) eased from 7.0% year-on-year in February to 6.3% in March in line with consensus forecast. The decline is attributed to the base effect of high year-ago comparative figures and the sharp fall in fuel price inflation which declined from 20.7% on the year in February to 3.8% in March. However, food price inflation was higher than anticipated rising 1.7% month-on-month and 9.5% on the year. Encouragingly core CPI, excluding food and energy prices, unexpectedly fell from 5.7% to 5.4% well below the 5.8% consensus forecast. On a month-on-month basis core CPI increased by less than 0.2% the lowest since February 2012. The rebound in the rand since the start of the year coupled with sharply lower core CPI may deter the SA Reserve Bank from hiking its benchmark repo interest rate at the upcoming policy meeting in May, especially in the context of subdued economic growth.
• All but one of the 17 economists surveyed this week by Reuters expect Standard & Poor’s to downgrade SA’s foreign currency sovereign credit rating to sub-investment grade this year. While SA’s bonds are already trading in line with “junk” status and therefore largely pricing-in a downgrade there would still be significant capital outflows in the event of an actual downgrade. A downgrade would induce forced selling by institutions which only have a mandate to purchase investment-grade bonds. Of the 17 economists surveyed ten said a cut to sub-investment grade would be negative for markets and six said it would be very negative.
The week ahead
• SA Reserve Bank (SARB) composite lead indicator: Due Tuesday 26th April. The composite lead indicator, measuring conditions in both manufacturing and service sectors of the economy, provides a forward-looking measure of economic conditions. In February the SARB composite lead indicator fell -0.6% to 92.2 but is expected to show some revival in March helped by a rebound in the rand and firmer commodity prices.
• Producer price inflation (PPI): Due Thursday 28th April. According to consensus forecast PPI is expected to moderate from 8.1% year-on-year in February to 6.5% in March, helped by the stronger rand. The base effect of elevated year-ago comparative levels is also playing a part, with expectations for a less pronounced moderation in month-on-month PPI from 1.0% to 0.8%.
• Private sector credit extension (PSCE): Due Friday 29th April. Having accelerated from 8.5% year-on-year growth to 9.0% between January and February PSCE is expected to show no change in the rate of growth in March according to consensus forecast. PSCE is being constrained by weak economic growth and stricter lending standards.
• Trade balance: Due Friday 29th April. The trade balance narrowed sharply from –R18bn in January to –R1bn in February and is expected to show a further improvement in March registering a trade surplus of +R2.0bn according to consensus forecast.
Technical analysis
• The rand remains below successive support levels suggesting a continuation in the rand’s depreciation.
• The US dollar index is testing a major 30-year resistance line, which if broken will pave the way for further strong gains in the currency.
• Despite the recent uptick in bond yields the long-term JPMorgan global bond index bull trend remains intact, with the yield targeting a new low during the fifth and final wave.
• The US 10-year Treasury yield has broken above key resistance levels of 1.8% and 2.0%. However, there is unlikely to be a major bear trend in US bonds as the deleveraging phase is still in its early stages.
• The benchmark R186 SA Gilt yield broke out of its long-term bull trend as a result of “Nenegate”. The new bear trend for the R186 is underpinned by resistance at 9.0% with a risk of further upside to 10.50%. While SA bond yields may fall in line with global bonds they are unlikely to return to the bull trend.
• The MSCI World Equity index has broken downward from a rising trendline which has been intact since the 2008/09 global financial crisis. Given the magnitude and duration of the 2009-2015 bull market the overall correction is likely to reach a downside target for the MSCI World Equity index of 1,400.
• Since the 1950s the Dow Jones and S&P 500 have displayed 7-year up-cycles and the top of the current US equity cycle is likely to have just occurred. The next major wave down will complete the 16-17 year secular bear market that started in 2000. The secular bottom should occur around June 2016.
• The S&P 500 index has broken downward from a rising wedge pattern, which is traditionally a trend-changing pattern. The downward trend is likely to remain intact unless the index decisively regains the 2070 level. A further negative signal is that the Dow Jones Transport Index, traditionally a lead indicator for the broader market, is leading the broader market lower on the downside.
• Despite the recent price rally Brent crude’s break below the key $30 support level in February suggests a continuation of the weakening long-term trend to a downside $25 target. Copper is regarded a reliable lead indicator for industrial commodity prices and barometer of global economic growth. Despite its recent rally the copper price broke below the key $4 500 support level in February suggesting further downside ahead.
• Gold has broken its recent downtrend by rising decisively above the $1 100 resistance level. An extended break above $1250 is needed to confirm the end of gold’s bear market.
• The JSE All Share index is testing an important resistance line but if this remains unbroken the index is likely to move back below the 24-month moving average at 50 700 in turn opening a downside target of 45 000 and an ultimate target of 43 000.
The bottom line
• Technical analysis indicates that local equities are due for a correction. The JSE All Share index has climbed +17% from its lows of early January, rising from 46 000 to 54 000. However, there is a pattern of successively lower highs and momentum indicators are on a downward trajectory indicating trouble ahead.
• From a fundamental viewpoint an equity market correction would come as no surprise. The price-earnings multiple of the JSE All Share index is 21.79x which seems extremely expensive compared to the 14.70x long-term average. With a GDP growth forecast of 0.7% this year and under 1.5% in 2017 amid rising interest rates and policy uncertainty it is hard to justify the lofty valuations.
• The JSE’s over-valuation is largely explained by the recent weakness of the US dollar. A weak dollar promotes the dollar price of oil and commodities and risk assets such as emerging market currencies and emerging market assets. The dollar index has lost -7.5% since its recent peak in mid-January, which is one of the largest dollar declines within a long-term dollar bull market.
• Assuming we remain in a dollar bull-market, the dollar is long overdue a resumption of its long-term appreciation, which would impact all the “risk assets” (emerging market currencies and emerging market assets) that have performed so well over the past three months. It is easy to argue that the dollar remains in a long-term bull market given the continued sustainable recovery of the US economy relative to other economies, and the widening interest rate differential between the US and other countries.
• The catalyst for the dollar to resume its uptrend would be an unexpected rate hike by the Federal Reserve. With US unemployment at 5% and little slack remaining in the labour market wage pressure is starting to build-up. US consumer price inflation is already at 2.3%, above the Fed’s 2% target and now that the dollar has weakened the Fed may be bolder in normalising interest rates.
• There is a strong likelihood that the Fed will hike the benchmark fed funds rate twice this year starting with a 25 basis point rate hike in June. Since the futures market is attributing only a 15% probability of a Fed rate hike in June this outcome would provide a potential shock to commodity prices and emerging market equity prices. The days of >20x price-earnings multiples for the JSE may be numbered.
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* Overberg Asset Management (OAM) is an Authorised Financial Services Provider No. 783. Overberg specialises in the private management of local and global discretionary portfolios as well as pension products.
Disclaimer: Information and opinions presented in this report were obtained or derived from public sources that Overberg Asset Management believes are reliable but makes no representations as to their accuracy or completeness. Any opinions, forecasts or estimates herein constitute a judgement as at the date of this Report and should not be relied upon. There can be no assurance that future results or events will be consistent with any such opinions, forecasts or estimates. Furthermore, Overberg Asset Management accepts no responsibility or liability for any loss arising from the use of or reliance placed upon the material presented in this report.
